The US Supreme Court’s decision in Lexmark could severely harm American businesses

The US Supreme Court’s decision in Lexmark could severely harm American businesses

As this blog has pointed out, of all the recent patent decisions from the US Supreme Court its ruling in Impression Products v Lexmark International is proving to be a particular cause for concern among some members of the patent licensing community. The case concerns patent exhaustion and, according to Lillian Shaked of Shaked & Co, throws up several problems for patent owners in the US. In this guest post she outlines just what she finds most troubling about the court’s decision:

I am not a patent attorney, a patent prosecutor or a patent litigator. I am not even American. I am a Canadian born corporate attorney who has been practising technology and IP licensing; and patent licensing, in particular, for years. Maybe for one or all of those reasons, the case references, analogs, well-drafted judgment and overall respect for the judges of the Supreme Court of the United States are not enough to convince me that their recent decision on patent exhaustion in Impression Products Inc v Lexmark International Inc was the correct one.

In Lexmark, the court held that after the sale of a patented item, the patent holder cannot sue for patent infringement relating to further use or sale of that item, even if the use or sale was in violation of the sale contract. Further, SCOTUS held that the patent holder cannot sue regarding the import, sale or use of an item in the US if it was originally sold outside the US.

The holding is troublesome for me from a number of perspectives.

The first, as to whether patent exhaustion should apply in the event the sale contract was breached.

The second, as to whether patent exhaustion should apply to the sale of an item that is not the same as the item that was first sold.

The third, as to whether a sale made outside the United States should exhaust a patent holder’s rights with respect to future sales in the United States (and possibly elsewhere in the world).

The Lexmark case concerned a patent infringement lawsuit brought by Lexmark against Impression Products. Impression Products bought used ink cartridges that were originally manufactured and sold by Lexmark then were “hacked” and embedded with an unauthorised replacement chip, refilled and resold. Lexmark argued that it owned several patents related to the ink cartridges and Impression Products was violating its patent rights. SCOTUS, reversing a 2016 decision of the Court of Appeals for the Federal Circuit, held that the exhaustion doctrine prevented Lexmark's patent infringement lawsuit. The Supreme Court ruled that Lexmark, which had a clause in its sales contracts prohibiting the disposition of the ink cartridges for refill (other than by Lexmark), could potentially enforce the restrictions on use or resale under contract law, but that its remedies under patent law were exhausted.

Patent exhaustion is deemed to occur when a patentee first sells a product in an “authorised sale”. Under the principle of patent exhaustion: "An authorised sale of a patented article free[s] the article from any restrictions on use or sale based on patent laws." Said another way, when a patentee chooses to sell an item, that product “is no longer within the limits of the monopoly” [of patent protection] and instead becomes the “private, individual property” of the purchaser with the rights and benefits that come along with ownership.

Domestic sales exhaustion

The first question that comes to mind is whether a breach of the sales terms does or should result in the sale being an "unauthorised sale".

The Supreme Court stated in the Lexmark decision that a sale transfers the right to use, sell or import an item because those are the rights that come along with ownership, and the buyer is free and clear of an infringement lawsuit because once sold, the seller loses its exclusionary rights to enforce. The argument is that this principle benefits commerce and limits restraints on the alienation of goods in commerce. The understanding is that if a patentee sells an item, it has secured the financial reward for its invention and patent law should provide no basis for further restraining the use and enjoyment of the product sold.

The Supreme Court held that even when a patentee sells an item under an express restriction, the patentee does not retain patent rights in that product if the restriction is breached. In its decision the court cited previous precedents; however, in those cases the restrictions on sale related to resale price restrictions, which are illegal. The Supreme Court did not differentiate between a breach of a presumably illegal restriction and a breach of a presumably legal one.

Did Lexmark in fact secure its financial reward? Would Lexmark have sold its products for the price it did, based on the assumption that it would receive the empty cartridges back, had it known that its products would later be hacked, refitted, refilled and sold in competition?

Let us assume that instead of the sale, Lexmark licensed the cartridges for a single use and sold the ink, with the licence agreement stipulating that the cartridges must be returned at the end of the use. Would it have been better off? The Supreme Court recognised in its decision that a patentee can impose restrictions on a licensee because a licence does not implicate the same concerns about restraints on alienation and in the case of a licence the restrictions would likely be enforceable and not affect the licensor’s patent rights.

According to the Supreme Court, a licence is not about passing title to a product and only an item that passes into commerce though a sale must be free from restrictions on future dispositions. Since Lexmark intended to have the cartridges returned, it appears that it would have been better off licensing them for use with a requirement to return them. It is unclear how encouraging a more complex transaction between Lexmark and its customers (ie, a licence and return stipulation as opposed to a sale with a return stipulation) would benefit commerce. In any event, the Supreme Court concluded on this point that despite Lexmark’s sale terms’ requirement that the empty cartridges be returned, the sale was an “authorised sale” and thus free from any further restrictions under patent law.

Another question I struggle with is whether the item sold by Impression Products in a “subsequent sale” was in fact the same item sold in the first authorised sale

Lexmark sold ink-filled cartridges with Lexmark’s packaging. Impression obtained the empty cartridges that were then “hacked” and embedded with an unauthorised replacement part, then filled with ink and resold, presumably with Impression’s own packaging.

According to previous precedents, had Impression re-sold Lexmark ink-filled cartridges it obtained following the first authorised sale, the principle of patent exhaustion would have applied as Lexmark could not control its products once they were first sold. However, is it logical that a product that was sold in an authorised sale can be altered to remove parts, hacked, refilled, repackaged and resold and still be considered to be the same product that was originally sold in the authorised sale?

Is the reverse engineering of a product sold in an authorised sale to obtain parts for use in a competing product permitted under the principle of patent exhaustion? Where is the border between patent exhaustion and product laundering and piracy? The principle of patent exhaustion is to enable products to pass through primary and even secondary markets, but is it also to enable a third party to hack and compete with the original product? Once again, the question arises whether Lexmark obtained its financial reward from the sale, if the price was based on the assumption that it would receive the empty cartridges back, when in fact its products were hacked, refilled and sold in competition.

In Quanta Computer Inc. v LG Electronics Inc, the Supreme Court held that the exhaustion doctrine is triggered by an “authorised sale” of a component when the only reasonable and intended use of the component is to practise the patent and the component substantially embodies the patented invention by embodying its essential features. In the Quanta case, Quanta purchased microprocessor chips which Intel manufactured and sold under licence from LG, and used them to manufacture computers. LG claimed that since its licence agreement with Intel expressly stated that no licence was granted to any third party for combining licensed products with other products (for example, for combining Intel microprocessor products with other parts of a computer), Quanta’s computers infringed its patents. In the course of restating the patent exhaustion doctrine, the Supreme Court held that everything inventive about the patents is embodied in the licensed products (ie, the chips), which carry out all the inventive processes when combined, according to their design, with standard components.

No mention is made in the Lexmark case as to whether the empty patent cartridges alone embodied all of the essential features of Lexmark’s patents without regard to the chip or the ink. To distinguish the Quanta case from the Lexmark case, the very same Intel chips which were made under the LG licence were included in the Quanta computers (they were not “hacked” or refurbished), and the reasonable and intended use of the chips was for use in the computer. In the Lexmark case, the ink-filled cartridges were “hacked”, the chip was replaced and the cartridges refilled. Again, questions of financial reward and the benefit of commerce come to mind.

In deciding the case, the Supreme Court provided an analogy to copyright law. Under the first sale doctrine of copyright law, when a copyright owner sells a lawfully made copy of its work it loses the power to restrict the purchaser’s freedom “to sell or otherwise dispose of … that copy”. Putting aside the fact that the copyright exhaustion doctrine is codified, whereas patent exhaustion is not, the copyright doctrine provides that it is "that copy" of the copyright work that can be sold. If the buyer or a third party later edits, amends, modifies, etc the copyrighted work, it would likely not be subject to the exhaustion doctrine because it is no longer “that copy” of the copyrighted work. If an analogy is used, shouldn’t the same principle apply to patent exhaustion?

The Supreme Court does not address the question of whether in fact Impression’s product is “the same item” as Lexmark initially sold and it is possible that this argument was simply not made. In the Federal Circuit decision, the court, in a footnote, mentioned that Lexmark did not argue that the chip replacement and ink replenishment resulted in new articles, which would be outside the scope of the exhaustion doctrine. Had they done so, maybe the Supreme Court would have reached a different decision?

International sales exhaustion

The Supreme Court went further in its application of the patent exhaustion principle and in a precedential decision held that sales outside of the United States exhaust patent claims in the US.

In addition to sales of its cartridges in the US, Lexmark sold toner cartridges abroad. Impression Products acquired empty cartridges, then refurbished, refilled and imported them into the United States for sale. The Supreme Court held that, just as with one inside the US, an authorised sale outside the United States exhausts all rights under the Patent Act.

In its decision, the Supreme Court does not address the fact that there are individual patent systems in countries outside the United States and offered no position on local patent protection in such countries. Does the Supreme Court view all countries outside the United States as one territory? Does an American patent owner’s sale of a product to a party in the UK exhaust patent rights in France, Germany or Japan by virtue of the first sale? If the patent owner sold a product to a distributor in the UK who then sold it to a distributor in France who then breached its local distribution agreement and resold the product back in the United States, would the patent holder’s patent claims in the United States be exhausted? If the patent owner also had patents in the UK and France, would there be exhaustion by virtue of the sale from the US? Can a third party purchase a product outside the United States and resell it anywhere in the world including back into the United States? If any of the above is answered in the affirmative, the Supreme Court in its decision appears to be doing away with territorial sales arrangements which could severely harm American businesses.

Once again the Supreme Court in its decision used an analogy from copyright law. It stated that since the principle against restriction on alienation has no geographical distinctions and the Copyright Act does not provide for such a distinction, and since both copyright and patent exhaustion have the same roots, the international copyright exhaustion principle should apply to patent law. Further, the Supreme Court stated that nothing in the Patent Act shows that Congress intended to confine the exhaustion principle to domestic sales. According to the Supreme Court, restrictions and location are irrelevant for patent exhaustion; what matters is only the patentee’s decision to make a sale.

It appears that the copyright analogy is a peculiar one. As discussed above, the doctrine of exhaustion is covered in the Copyright Act whereas the Patent Act contains no such doctrine. Therefore relying on the absence of a distinction in the Copyright Act between a sale in the United States and a sale abroad to conclude that copyright exhaustion is not limited to the United States, in a situation in which patent exhaustion does not have a statutory basis, seems a bit of a stretch. Further, whereas copyright protections are harmonised across countries, patent protection is territorial and relies on the individual local laws of the different countries.

In her dissenting opinion, Justice Ginsburg argued that since patent law is territorial and the sale of an item abroad is independent of the US patent system, it makes little sense to say that a sale outside the United States exhausts an inventor's patent rights in the country. According to Justice Ginsburg, a United States patentee must apply to each country in which he or she seeks the exclusive right to sell an invention. Upon grant, a patentee should then be entitled to benefit in the relevant country from the protection its patents afford.

I question whether the Supreme Court considered the implications the decision would have on American businesses that sell locally and internationally. By exhausting a patent owner’s patent rights in the United States through a sale outside the country, the Supreme Court is in essence allowing international competitors to obtain products abroad and import them into the US without offering the patent holder protection under United States patents.

If the Supreme Court’s position is that any sale is an authorised sale regardless of a breach of the conditions of sale, a breach of the territorial restrictions on sale would not affect exhaustion and there would be no protection from a patent standpoint if territorial distribution agreements are breached.

If Lexmark licensed rather than sold its cartridges abroad, it would appear to be able to enforce its licence agreements (even if done on a territorial basis) and prevent the reimportation of the products without giving up its patent coverage.

In conclusion, while the Supreme Court’s decision appears to be a very liberal one that is meant to benefit commerce and trade, it would appear that in fact it has the potential of weakening American businesses and their ability to compete internationally and actually may make trade more complex, if companies consider implementing licensing models in lieu of product sales.